An expert on electronics manufacturing argues that the first EMS providers about to move up the manufacturing value chain will have a leg up on other competitors seeking to expand their operations.
Electronic Manufacturing Service (EMS) companies have enjoyed a reasonably rapid growth in revenue in the last 30 years. However, the marketplace is experiencing significant structural change with the result that EMS companies are at the crossroads relative to their future strategy, and the future of several major EMS companies will be determined in the next five years.
About 30 years ago, the EMS industry was born as large OEMs sought to outsource manufacturing. The primary economic drivers for this outsourcing were:
- OEMs’ desire to move fixed costs to variable costs
- The ability of an EMS to aggregate demand across multiple markets to maximize utilization of factories and enable bulk purchases for components
- EMS companies’ ability to specialize in manufacturing in order to increase operational efficiency
These drivers meant EMS companies such as Flextronics, Foxconn, and Jabil Circuit were able to grow very rapidly. In the process, they have created an ecosystem which can broadly be called “China Inc.” Despite the growth, EMS companies have managed to capture a very small slice of the value of the products they manufacture. This reflection of value can be seen by the operating margins of companies like Flextronics (2 percent) or Jabil Circuit (3.73 percent). Why such small values?
There are two reasons. In general, EMS companies do not control the design and associated bill of materials for products they produce. To the degree an EMS is allowed to make parts selection, they tend to be in commodity parts where the OEM is unconcerned about the part selection.
Second, EMS companies tend to manage each customer interaction as single stand-alone transaction. The consequence of this behavior is that each transaction is “safe” in terms of its relatively small margin, but this behavior does not allow for any real leverage across the enterprise.
Overall, the only real enterprise leverage point is around capital investments for factories and associated financial management. For the rest, the operating model is a large number of low margin services with very little leverage at the enterprise level.What is the problem?
To date, EMS companies have been satisfied with the status quo because there has been a focus on driving growth. Over time, there have also been efforts to increase margins with investments in components or even full products. However, it is exceedingly difficult for primary services cultures to shift to a product mode, and that has indeed been the case for EMS companies.